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Using Fair Value to Guide Two-Sided Order-Book Quotes

Article Quant Q&A · Author: autoregressive_monoid
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Summary

The document asks how a market maker should use a fair-value estimate when quoting in a central limit order book. It contrasts this setting with request-for-quote trading, where a dealer can present prices without competing against visible resting orders. In an order book, a fair value above the current ask would imply a bid that crosses the spread if quotes were placed symmetrically around that estimate.

The author considers joining the best bid in that case, while wondering whether quoting on only one side still counts as market making, and whether two-sided quotes make sense only when fair value equals the midpoint. These are posed as questions rather than answered conclusions. The text highlights the interaction between a value signal, queue position, the spread, and the choice to quote one or both sides, but gives no specific quoting rule, data, or performance evidence.

Key ideas

  • A fair-value estimate can differ from the midpoint of the visible order book.
  • Symmetric quotes around fair value may cross the spread when fair value lies outside the best bid and ask.
  • The question considers joining the best bid when estimated value is above the best ask.
  • The document does not resolve when a market maker should quote one side or both.

Tags

Market makingMarket microstructureExecution
Full text
# Quoting around fair value


# Quoting around fair value












When doing MM people in the industry say that most of the time they have a signal, which give them a faire value of the instrument and they quote around that. For RFQ it makes sense since there's no CLOB. Though for MM on CLOB I don't see how it makes sense. If the best bid is $b$ and the best ask is $a$, if the faire value is bigger than $a$ then I am not going to quote a round that since my bid will be higher than the best ask which doesn't makes sense.

Hence I am wondering for MM in orderbook what is the fair value used for?

One thing I can see is that in the example above is thta if the fair value is above the ask price then I can quote on the best bid. So I just add order on the best bid, but in that case I guess this doesn't make me a MM since I am quoting just one side. Or I just quote both side if the fair value I get is the current mid?

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.